ESG+ Newsletter – 06 July

ESG ratings and the role of regulation

Another week and another discussion on the future purpose of ESG ratings. An Op-Ed in the FT written by three MIT academics argues that any regulation of the ESG rating market should not synchronise the raters’ methodologies, rather, regulatory focus should be on the “standardising corporate ESG disclosure for a few core metrics that underpin all ratings”. They believe that greater transparency in how data is collected and aggregated, as well as an increased market understanding of what each rating agency is seeking to measure – either impact or financial materiality – will allow for greater scrutiny of the data, leading to more informed investment decision-making. Interestingly, the Op-Ed also argues that a focus on certain ESG metrics would result in shifting ESG ratings agencies’ business models to be more aligned with that of equity and credit research. ESG analysts would have to contextualize the data points and evaluate the latest disclosure, while potentially projecting companies’ progress over the coming years. As outlined in our review of the EU’s proposed regulation of the ESG ratings sector, the implementation of a regulatory framework should help shape what ESG ratings are for, and how should they be used. Whether competition and diversity of opinion on the myriad of ESG factors results in ESG rating agencies becoming more like equity and credit research remains to be seen.

Litigation funding driving change in ESG

As described by Reuters, litigation funding is “the payment by a third party of a claimant’s legal fees and other costs associated with the litigation, in return for a portion of any successful award of damages”. Litigation funding aims to democratise access to justice and may have the power to drive progress in the ESG agenda, with private consumer and shareholder plaintiffs making claims across a number of ESG areas, including environmental pollution, climate change, product liability, human rights abuses, and corporate misconduct. With investors looking to use as many tools as possible to pressurise companies into shifting business practices, the use of funds to support ESG litigation can challenge inadequate climate change policies or the focus on fossil fuels.

But investors themselves also face significant risks. Ignites Europe reports that asset managers face an elevated risk of legal action due to the volume of ESG documentation that they must produce, which goes well beyond that of other corporates. Vincent Hamelink, CEO of Candriam, argues that gaps in sustainable finance regulation – including in relation to what constitutes a sustainable investment – creates risks, and asset managers should engage with policymakers to make regulations that are “more transparent, simple, and aligned”. 

Pressure mounts on the role of offsets in climate action

The issue of offsets continues to attract attention, with a recent report highlighting that Nestlé has decided to change tack by moving away from offsets, and focus on investing in emission reductions. In short, the consumer food and beverage company is putting the money it would have spent on carbon credits into cutting emissions in its supply chain and operations. As noted in a recent Bloomberg article, the business has also dropped its “carbon neutral” claims on certain of its brands, including KitKat, and Perrier. To achieve its climate goals, the company has set short and medium-term climate reduction targets, including in relation to agricultural emissions in its supply chain, with its spokesperson stating in ESG Today that its net zero roadmap does not rely on offsets, instead focusing on “GHG emissions reductions and removals within our value chain to reach our net zero ambition.”  

While the use of carbon offsetting practices is part of many companies’ net-zero plans, a recent study by the NGO, Carbon Watch, found that the use of offsetting plans is a “major stumbling block for the credibility of corporate climate strategies”. The report found that the companies plan to offset between 23% and 45% of their combined emission footprint, which would require “a second planet Earth to absorb global emissions if everyone decided to offset like these corporations”. Companies’ carbon neutral and net zero claims have also come under significant scrutiny, with the UK’s advertising watchdog to begin stricter enforcement around the use of ‘carbon neutral’ and ‘net zero’ terms. Nestlé’s approach is aligned with best practices on acting on climate change, whereby companies must ultimately start with reductions in emissions before looking to supplement those actions with smaller amounts of offsets.

Financial services firms may be vastly underestimating financial impact of climate change

A joint report released this week by the Institute and Faculty of Actuaries (IFoA) and the University of Exeter, claims that many of the climate scenarios used by financial institutions to model climate risks are “far too benign and, in some cases, implausible”. The report, “The Emperor’s New Climate Scenarios – a warning for financial services”, warns that the risks posed by climate change are significantly underestimated and that current corporate climate scenario modelling has favoured overly simplified models to drive adoption, rather than prioritising accuracy. Climate scenario modelling is commonly used by financial institutions and corporates as part of processes to identify and manage climate-related risks, a key recommendation of the Taskforce on Climate-related Financial Disclosures, which has become the gold standard for investors and a growing number of regulators. The report flags three core issues with current climate scenario analysis – the underestimation of climate-related risks, the overestimation of remaining carbon budgets, and the prevalence of groupthink in widely accepted climate scenarios. While the financial services industry has come a long way in assessing climate-related financial risks, if inaccuracies persist, the usefulness of climate scenario analysis in its current form may be undermined.

Cybersecurity experts sought for board positions

As awareness of cyber risk grows, companies are increasingly looking to add cybersecurity expertise to their boards. The obvious candidate for a board role is the Chief Information Security Officer (CISO) however, according to CNBC, only 15% of CISOs possess the necessary traits to hold a board-level position. While CISOs are undoubtedly cybersecurity experts, they often lack the broader business experience that exposes them to a variety of operational models and corporate strategies, all of which are fundamental to board membership. Communication skills are also vital to effectively translate technical details into language that will resonate, and allow collaboration, with other board members. This is often a weak point for CISOs, with FTI Consulting’s recent CISO survey revealing that 58% of CISOs struggle to communicate effectively with senior leaders. CISOs also need a broader understanding of risk, including fiduciary and operational risk, for example, and not just technology risk. Having a cybersecurity expert on the board is key for companies to demonstrate that cybersecurity is being prioritised appropriately. However, with a recent report from IANS Research revealing that 90% of public companies lack a single cyber expert on their board, companies may need to fast-track getting their CISOs board-ready.

Can Chinese Banks go green?

Over the past decade, Chinese banks have been required to implement the Green Finance Guidelines which require banks and insurers to terminate funds for projects with significant risks and hazards and comply with international norms and standards, including as The Diplomat reports linking the bank’s green performance with staff reviews and compensation. However, evidence over the past decade indicates regulators have fallen short in monitoring the adoption of the guidelines. Chinese Banks at present are associated with a range of environmentally risky projects. In a report published by Global Witness, between January 2013 and April 2020, Chinese financial institutions provided more than $22.5 billion to major companies that produce and trade commodities at high risk of driving deforestation. Recent reports highlighting the role of Chinese banks came amid President Xi Jinping’s push to show China’s leadership in tackling climate change. With Beijing pledging that its emissions will peak by 2030, and it will be carbon neutral by 2060, the role of banking and finance in the transition will be as keenly debated in the East as it is in the West.

ICYMI

• AstraZeneca commits $400 million to reforestation program. AstraZeneca has announced a significant expansion of its reforestation and biodiversity-focused programme, AZ Forest, including a new $400 million investment and a commitment to plant 200 million trees by 2030. With this initiative, AstraZeneca’s efforts will span over 100,000 hectares worldwide, positively impacting an estimated 80,000 livelihoods, and removing approximately 30 million tonnes of CO2 from the atmosphere.
• 50% of CEOs have pay tied to ESG goals, up from 15% one year ago: IBM Survey. According to a new global CEO survey released by IBM, the practice of linking incentive pay for senior executives to performance on ESG factors has surged by 15% compared to last year, with around half of CEOs reporting that their compensation is now tied to sustainability goals. In addition to the rapidly growing integration of ESG factors into executive compensation, the survey also found that ‘environment’ and ‘sustainability’ was identified by CEOs as the most frequently cited key challenge over the next three years.
• US to lend $9.2 billion for Ford battery plants in clean energy push. The US Department of Energy plans to lend a record $9.2 billion for electric vehicle battery factories being constructed by carmaker Ford and South Korea’s SK On, as Washington pushes to develop domestic supply chains and reduce industrial reliance on China. The conditional loan forms part of a clean energy investment drive by the government, which was supercharged by last year’s passage of the Inflation Reduction Act.

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